As 16
As 16
CLASS WORK
Q-1 The company has obtained Institutional Term Loan of ` 580 lakhs for modernisation and
renovation of its Plant & Machinery. Plant & Machinery acquired under the modernisation
scheme and installation completed on 31st March, 20X2 amounted to ` 406 lakhs, ` 58 lakhs
has been advanced to suppliers for additional assets and the balance loan of ` 116 lakhs
has been utilised for working capital purpose. The Accountant is on a dilemma as to how
to account for the total interest of ` 52.20 lakhs incurred during 20X1-20X2 on the entire
Institutional Term Loan of ` 580 lakhs.
Q-2 H Ltd. incurs borrowing costs for the purpose of construction of a qualifying asset for its
own use. The construction gets completed on May 31, 20X1. However, decoration work is
under process which is expected to be completed by November 20X1 after which H Ltd. will
be able to start using the said asset for its own use. H Ltd. wants to capitalize the eligible
borrowing costs incurred up to November 20X1.
Ans. The capitalization of borrowing costs shall cease when substantially all the activities
necessary to prepare the qualifying assets for its intended use or sale is completed.
In the given case, H Ltd. should capitalize borrowing costs only up to May 31, 20X1. The
borrowing cost incurred thereafter cannot be capitalized as the asset was ready for its
intended use on May 31, 20X1. The fact that decoration work was being carried out should
not be considered as the asset was ready for its intended use on May 31, 20X1.
Q-3 ABC Ltd. is in the process of getting an entertainment park constructed. For this purpose,
it has taken loan from a bank. The said park consists of several rides and facilities, each of
which can be used individually. Three fourth part of the park has been constructed and can
be opened up for public, while construction on the remaining part is continuing. Whether
the capitalization of borrowing cost should continue for the whole park until construction
continues?
Ans. ABC Ltd. is in process of constructing an entertainment park which consists of several rides
and facilities that can operate independently for their intended use. Even though the park
as whole is not complete, the individual facilities are ready for their intended use.
The cessation of capitalization depends upon the nature of the qualifying assets, particularly
where the qualifying assets consists of various parts. There are qualifying assets where each
part is capable of being used while the construction continues on other parts. There are
qualifying assets where all parts have to be completed before any earlier completed part
can be put to use.
Since in the given scenario, the individual facilities are capable of operating independently
and are ready for their intended use, therefore the borrowing costs shall cease to be
capitalized for the three-fourth part of the project.
Q-4 Harish Construction Company is constructing a huge building project consisting of four
phases. It is expected that the full building will be constructed over several years but Phase
I and Phase II of the building will be started as soon as they are completed.
Following is the detail of the work done on different phases of the building during the
current year:
Phase I Phase II Phase III Phase IV
` ` ` `
Cash expenditure 10 30 25 30
Building purchased 24 34 30 38
Total expenditure 34 64 55 68
Total expenditure of all phases 221
Loan taken @ 15% at the beginning 200
of the year
During mid of the current year, Phase I and Phase II have become operational.
Find out the total amount to be capitalized and to be expensed during the year.
Q-5 Paras Ltd. had the following borrowings during a year in respect of capital expansion.
` in lakhs
Construction of Factory shed 25
Purchase of Machinery 20
Working capital 15
Advance for purchase of Truck 10
In March 2011, construction of the factory shed was completed and machinery, which was
ready for its intended use, was installed. Delivery of Truck was received in the next financial
year. Total interest of `9,10,000 was charged by the bank for the financial year ending 31-
03-2011.
Show the treatment of interest under AS 16and also explain the nature of Assets.
Q-9 Axe Limited began construction of a new plant on 1st April, 2011 and obtained a special loan
of ` 4,00,000 to finance the construction of the plant. The rate of interest on loan was 10%.
The expenditure that were made on the project of plant were as follows:
`
1st April, 2011 5,00,000
1st August, 2011 12,00,000
1st January, 2012 2,00,000
The company’s other outstanding non-specific loan was ` 23,00,000 at an interest rate of
12%.
The construction of the plant completed on 31st March, 2012. You are required to:
(a) Calculate the amount of interest to be capitalized as per the provisions of AS 16
“Borrowing Cost”.
(b) Pass a journal entry for capitalizing the cost and the borrowing cost in respect of the
plant.
Q-10 On 1st April, 2011, Amazing Construction Ltd. obtained a loan of `32 crores to be utilized as
under:
(i) Construction of sealink across two cities: `25 crores
(work was held up totally for a month during the year
due to high water levels)
(ii) Purchase of equipments and machineries `3 crores
(iii) Working capital `2 crores
(iv) Purchase of vehicles `50,00,000
(v) Advance for tools/cranes etc. `50,00,000
(vi) Purchase of technical know-how `1 crores
(vii) Total interest charged by the bank for the year ending 31 st March, `80,00,000
2012
Show the treatment of interest by Amazing Construction Ltd.
Q-11 A company capitalizes interest cost of holding investments and adds to cost of investment
every year, thereby understating interest cost in profit and loss account. Comment on the
accounting treatment done by the company in context of the relevant AS.
218 Navkar Institute
CHAPTER-5 Assets Based Accounting Standards
Q-12 Take Ltd. has borrowed `30 lakhs from State Bank of India during the financial year 2016-
2017. The borrowings are used to invest in shares of Give Ltd., a subsidiary company of
Take Ltd., which is implementing a new project, estimated to cost `50 lakhs. As on 31st
March, 2017, since the said project was not complete, the directors of Take Ltd. resolved to
capitalise the interest accruing on borrowings amounting to `4 lakhs and add it to the cost
of investments. Comment.
Q-13 ABC Ltd borrowed 1,00,000 US $ on 1st April, 2017 @ 5% p.a. interest to acquire qualifying
asset. If the same loan is borrowed in India then it would cost 11% p.a. interest. The qualifying
asset was ready for its intended use on 31-3-2018. The details of foreign exchange rates
were as follows:
On 1-4-2017 1 US $ = 60 INR
On 31-3-2018 1 US $ = 65 INR
Give appropriate treatment of Borrowing cost for the year ended 31st March, 2018 as per
para 4(E) of As-16.
Q-14
Assume NDA Limited begins Construction on a new building on 1st January, 2004. In addition
NDA Limited obtained a Rs. 1 lakh loan to finance the construction of the building on 1st
January, 2004 at an annual interest rate of 10%. The company’s outstanding debt during
2004 Consists of two loans of Rs. 6 lakhs Rs.8 lakhs with interest rates of 11% and 13%,
respectively. Expenditure that were made on the building project were as follows:
Amount (`)
January, 2014 3,00,000
April, 2014 3,50,000
July, 2014 5,50,000
December, 2014 1,50,000
Building was completed on 31st December, 2014. Following the principles prescribed in AS 16
‘Borrowing Cost’, calculate the amount of interest to be capitalized and pass one Journal
Entry for capitalizing the cost-and borrowing in respect of the building.
Ans. Average expenditure Rs. 8,50,000. Capitalisation rate for Non specific loans 12.29%. Interest
capitalised Rs. 1,03,595 ( 36,000 on specific loan and Rs. 67,595 on non specific loan of Rs.
5,50,000.
Q-19 A company incorporated in June 2017, has setup a factory within a period of 8 months with
borrowed funds. The construction period of the assets had reduced drastically due to usage
of technical innovations by the company. Whether interest on borrowings for the period
prior to the date of setting up the factory should be capitalized although it has taken less
than 12 months for the assets to get ready for use. You are required to comment on the
necessary treatment with reference to AS 16.
Ans. As per para 3.2 to AS 16 'Borrowing Costs', a qualifying asset is an asset that necessarily
akes a substantial period of time to get ready for its intended use or sale.
Further, Explanation to the above para states that what constitutes a substantial period
of time primarily depends on the facts and circumstances of each case. However, ordinarily,
a period of twelve months is considered as substantial period of time unless a shorter
or longer period can be justified on the basis of facts and circumstances of the case. In
estimating the period, time which an asset takes, technologically and commercially, to get
it ready for its intended use or sale is considered.
It may be implied that there is a rebuttable presumption that a 12 months period constitutes
substantial period of time.
Under present circumstances where construction period has reduced drastically due to
technical innovation, the 12 months period should at best be looked at as a benchmark and
not as a conclusive yardstick. It may so happen that an asset under normal circumstances
may take more than 12 months to complete. However, an enterprise that completes the asset
in 8 months should not be penalized for its efficiency by denying it interest capitalization
and vice versa.
The substantial period criteria ensures that enterprises do not spend a lot of time and effort
capturing immaterial interest cost for purposes of capitalization.
Therefore, if the factory is constructed in 8 months then it shall be considered as a qualifying
asset. The interest on borrowings for the same shall be capitalised although it has taken
less than 12 months for the asset to get ready to use.
Q-20 In May, 2016, Capacity Ltd. took a bank loan to be used specifically for the construction of a
new factory building. The construction was completed in January, 2017 and the building was
put to its use immediately thereafter. Interest on the actual amount used for construction
of the building till its completion was Rs.18 lakhs, whereas the total interest payable to the
bank on the loan for the period till 31st March, 2017 amounted to Rs. 25 lakhs.
Can Rs. 25 lakhs be treated as part of the cost of factory building and thus be capitalized
on the plea that the loan was specifically taken for the construction of factory building?
Explain the treatment in line with the provisions of AS 16.
Ans. AS 16 clearly states that capitalization of borrowing costs should cease when substantially
all the activities necessary to prepare the qualifying asset for its intended use are completed.
Therefore, interest on the amount that has been used for the construction of the building up
to the date of completion (January, 2017) i.e. Rs.18 lakhs alone can be capitalized. It cannot
be extended to Rs.25 lakhs.
Q-21 ABC Limited has started construction of an asset on 1st December, 2020, which continues till
31st March, 2021 (and is expected to go beyond a year). The entity has not taken any specific
borrowings to finance the construction of the asset but has incurred finance costs on its
general borrowings during the construction period. The directly attributable expenditure at
the beginning of the month on this asset was ` 10 lakh in December 2020 and ` 4 lakh in
each of the months of January to March 2021. At the beginning of the year, the entity had
taken Inter Corporate Deposits of ` 20 lakh at 9% rate of interest and had an overdraft of
` 4 lakh, which increased to ‘ 8 lakh on 1st March, 2021. Interest was paid on the overdraft
at 10% until 1st January, 2021 and then the rate was increased to 12%. You are required to
calculate the annual capitalization rate for computation of borrowing cost in accordance
with AS 16 ‘Borrowing Costs’.
Q-22 The borrowings profile of Santra Pharmaceuticals Ltd. set up for the manufacture of
antibiotics at Navi Mumbai is as under:
`
Sterile Manufacturing shed 10,00,000
P lant and machinery (total) 90,00,000
Other fixed assets 10,00,000
The Project is completed on 1st January, 2017 and is ready for commercial production. Show
the capitalization of the borrowing costs.
Q-23 Fee Ltd. borrows a sum of ` 20 crore from Coffee Ltd., repayable as a single bullet payment at
the end of 5 years. The interest thereon @ 5% p.a. is payable at yearly rests. Since the market
is 8%, Fee Ltd. paid an origination fee of ` 2.40 crores to Coffee Ltd. to compensate Coffee
Ltd. for the lower rate of interest. Apart from the above, there are no other transactions
between the two parties. You are required to show the value at which Coffee Ltd., would
recognize the loan and the annual interest thereon.
MCQS
1. As per AS 16, all the following are qualifying assets except
(a) Manufacturing plants and Power generation facilities
(b) Inventories that require substantial period of time
(c) Assets those are ready for sale.
(d) None of the above
2. Which of the following statement is correct:
(a) Entire exchange gain is reduced from the cost of the Qualifying asset.
(b) Entire exchange loss is added to the cost of a Qualifying asset.
(c) No adjustment is done for the exchange loss while computing cost of Qualifying
asset.
(d) None of the above
3. Capitalisation rate considers:
(a) Borrowing costs on general borrowings only.
(b) Borrowing costs on general and specific borrowings both.
(c) Borrowing costs on specific borrowings only
(d) None of the above
4. If the amount eligible for capitalisation in case of inventory as per AS 16 is ` 12,000 and
cost of inventory is ` 40,000 and its net realizable value is ` 45,000; What amount can be
capitalised as a part of inventory cost.
(a) ` 12,000. (b) ` 5,000. (c) ` 7,000. (c) ` 10,000.
5. X Ltd is commencing a new construction project, which is to be financed by borrowing. The
key dates are as follows:
(i) 15th May, 20X1: Loan interest relating to the project starts to be incurred
(ii) 2nd June, 20X1: Technical site planning commences
(iii) 19th June, 20X1: Expenditure on the project started to be incurred
(iv) 18th July, 20X1: Construction work commences Identify the commencement date for
capitalisation under AS 16.
(a) 15th May, 20X1. (b) 19th June, 20X1.
(c) 18th July, 20X1. (d) 2nd June, 20X1
Answers
HOME WORK
Q-1 When capitalization of borrowing cost should cease as per Accounting Standard 16? Explain
the provision.
Ans. Capitalization of borrowing costs should cease when substantially all the activities necessary
to prepare the qualifying asset for its intended use or sale are complete. An asset is normally
ready for its intended use or sale when its physical construction or production is complete
even though routine administrative work might still continue. If minor modifications such
as the decoration of a property to the user’s specification, are all that are outstanding,
this indicates that substantially all the activities are complete. When the construction of a
qualifying asset is completed in parts and a completed part is capable of being used while
construction continues for the other parts, capitalisation of borrowing costs in relation to
a part should cease when substantially all the activities necessary to prepare that part for
its intended use or sale are complete.
Q-2 Sun Co-operative Society Ltd. has borrowed a sum of US$12.50 million at the commencement
of the financial year 2016-2017 for its solar energy project at LIBOR (London Interbank
Offered Rate) of 1% + 4%. The interest is payable at the end of the respective financial
year. The loan was availed at the then rate of ` 45 to the US dollar while the rate as on
31st March, 2017 is ` 48 to the US dollar. Had Sun Co-operative Society Ltd. borrowed the
Rupee equivalent in India, the interest would have been 11%. You are required to compute
‘Borrowing Cost’. Also show the amount of exchange difference as per prevailing Accounting
Standards.
Q-3 X Limited began construction of a new plant on 1st April 2016 and obtained a special loan
of ` 8 lakhs to finance the construction of the plant. The rate of interest on loan was 10 per
cent per annum.
The expenditure that was made on the project of plant construction was as follows:
`
1-4-2016 10,00,000
1-8-2016 24,00,000
1-1-2017 4,00,000
The Company’s other outstanding non-specific loan was ` 46,00,000 at an interest of 12
percent per annum.
The construction of the plant was completed on 31-3-2017. You are required to calculate
the amount of interest to be capitalized as per the provision of AS 16 of the borrowing cost
(including cost).